Core CPI Has Reversed A 40-Year Lower Peak-to-Peak Business Cycle Pattern: How High Will It Go?
The scale of the current consumer price inflation cycle has caught many analysts and policymakers by surprise. And instead of acknowledging the risk of a persistent increase in inflation, several private-sector analysts and policymakers cite special or one-time factors for the jump, concluding the current spurt is nothing more than a transitory or temporary phenomenon.
Inflation has befuddled many (including me) for decades. However, the current inflation cycle has easy money and tightening product and labor markets that have been at the center of prior price cycles. As such, the suggested reasons for this price cycle to be a blip seem dubious.
Whatever the outcome, the current price cycle has reversed the lower peak-to-peak core inflation rate pattern in the business cycles of the past 40 years. How high and for how long it goes depends on Fed policy.
Every inflation cycle has unique factors. But powerful common themes run through the long history of price cycles. At the center are easy money and credit and tightening product and labor markets.
In the middle of rapid and aggressive tightening of monetary policy in 1994, Federal Reserve Chairman Alan Greenspan questioned the scale and length of that cyclical inflation cycle. That's because although there was evidence of increasingly tight labor and product markets, fast money and credit growth were missing. Mr. Greenspan ended up being right, but it took a 300 basis point increase in official rates to quell the upward pressure on consumer prices.
Today, both root causes of price cycles are present. Broad money growth has been running at record rates for the past year. Manufacturers' purchasing agents report that customer inventories are at record lows, with backlogs surging. Also, at the start of the current business cycle, job vacancies are three to four times greater than the prior two cycles.
Yet, policymakers are operating with the view that the jump in inflation is a blip. The trouble with blips is that one can only know for sure after the fact, and from a risk-management perspective, policymakers need to be concerned about being wrong since the costs are considerable.
Press and analyst commentary about the recent rise in consumer price inflation is off-base. Many argue the primary cause of the 0.6% jump in core CPI is the significant increase in used car and truck prices (7.3%) due to the reopening of the economy and increased travel. Yet, the Bureau of Labor Statistics reported core CPI less used cars and trucks and shelter increased a like amount (0.6%). In other words, weakness in shelter prices exerted as much downward pressure on core CPI as used cars and truck prices exerted upward pressure.
Price cycles are never smooth or even, and as significant price increases in one product group eases others perk up. In the coming months, core CPI will see more significant upward price pressure emanating from rents (a component with ten times the weight of used cars and trucks) and less from used car and truck prices. That's because CoreLogic's rental survey shows market rents have increased 4.3% in the past twelve months, twice that of CPI rents. Market rents tend to lead to changes in CPI rents by six months or more.
One major takeaway from the inflation data is that 2021 core consumer prices reversed a 40 year lower peak-to-peak business cycle pattern. A 5% peak in the 1980s dropped to 3.0% in the 1990s, 2.5% in 2000, and less than 2.5% in the cycle that ended in 2020. So the current core CPI reading of 3.8% has already surpassed the highs of the 1990s. Next up is the 1980s high of 5%.
The current playbook for monetary policy looks like that of the 1970s. Monetary policy is operating with official rates far below inflation and even denying that easy money is stoking inflation sounds similar to the denials of the 1970s. Thus, the odds that core inflation exceeds the highs of the 1980s increase with each passing day. Investors forewarned.